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The only reason to buy an asset manager's shares, the thinking goes, is because the market is heading higher. Based on that view, there is little reason to own
Waddell & Reed FinancialWDR 0.10090817356205853%Waddell & Reed Financial Inc.U.S.: NYSEUSD49.6
0.050.10090817356205853%
/Date(1425420252301-0600)/
Volume (Delayed 15m)
:
941478AFTER HOURSUSD49.6
%
Volume (Delayed 15m)
:
14943
P/E Ratio
13.333333333333334Market Cap
4140645807.21664
Dividend Yield
3.467741935483871% Rev. per Employee
972637More quote details and news »WDRinYour ValueYour ChangeShort position
if you believe Chief Executive Hank Herrmann's dour market forecast. "We've run up a lot in anticipation that Europe will take care of its solvency issues and China can reverse a continued weakening in its economy," says Herrmann, a longtime investor. If neither occurs, "there will be a pullback in stocks."

When annual earnings growth is robust, however, and the company pays a stout 3.4% dividend yield, a rethink is in order. Even more compelling in Waddell's case, its shares (ticker: WDR) have lagged the market, falling 5% in the past year, to $29.25, due to a rare stumble by the company's flagship fund and worries about investor redemptions.

CEO Hank Herrmann was a successful analyst and investor before taking the reins.
Courtesy of Waddell & Reed

The underperformance has obscured a long history of asset growth, superior mutual-fund performance, and a penchant for returning capital to shareholders. Says Tim Dalton, chairman of Dalton Greiner Hartman Maher, a New York-based value investor, "Waddell is about as attractively priced as it's ever been. The yield is above average, the valuation below average. Even if global markets stay choppy, the company will continue to grow earnings. You're looking at a 10%-plus [investment] return, and if you get some improvement in the market, you can get returns significantly higher."

FOUNDED IN 1937 BY TWO WORLD WAR I veterans, Chauncey Waddell and Cameron Reed, the firm, based in Overland Park, Kan., celebrates its 75th anniversary this year. It keeps a fairly low profile. With just under $90 billion in assets, W&R is a shrimp compared with
BlackRockBLK -0.7332235269114287%BlackRock Inc.U.S.: NYSEUSD373.66
-2.76-0.7332235269114287%
/Date(1425420083372-0600)/
Volume (Delayed 15m)
:
420746AFTER HOURSUSD373.68
0.01999999999998180.005352459455119627%
Volume (Delayed 15m)
:
8195
P/E Ratio
19.08375893769152Market Cap
62189857798.5889
Dividend Yield
2.3336723224321574% Rev. per Employee
986491More quote details and news »BLKinYour ValueYour ChangeShort position
(BLK), with $3.56 trillion, and Vanguard, at $1.6 trillion. The last time it hit the headlines was in 2010, when its flagship
Waddell & Reed Asset Strategy
fund (UNASX) was implicated in triggering the "flash crash." (The Dow, which suddenly plunged almost 1,000 points, recovered in minutes, and W&R faces no financial liabilities tied to the incident.)

Waddell & Reed Financial / WDR

Recent Price

$29.25

52-Week Range

$33.58 - $22.85

Market Value

$2.5 bil

Revenue 2012E

$1.2 bil

EPS 2012E

$2.13

EPS 2013E

$2.38

P/E 2013E

12.3

5-Yr Hist EPS Growth

11%

Assets Under Mgmt

$89 bil

Dividend Yield

3.4%

E=Estimate.

Even as the market churned in the past decade, W&R has grown steadily, grabbing share from other fund companies whose investment flows also were dented by the growth of exchange-traded funds. Credit strong returns under Herrmann, a former technology analyst and lead investor who has run the whole shebang since 2005. For the past four years, either the firm's Waddell & Reed funds or its Ivy funds have held the top spot in Barron's Best Mutual Fund Families ranking. More than half of W&R's dozens of funds earn four or five stars from Morningstar. About 80% of assets are in equity funds, most of them managed in the growth style.

Today Waddell has 1,764 financial advisors who sell the Waddell & Reed funds. The company introduced the Ivy funds in 2003, which are sold by wirehouse brokers outside the W&R system. "This allowed us to distribute in the broker/dealer world without channel conflict," says Herrmann. "Suddenly there were 30,000 people instead of 1,500 selling our product."

The third leg of growth comes from subadvising funds in retirement plans.

In recent years, W&R's flagship Asset Strategy fund has been its top seller. This fund and
Ivy Asset Strategy
(WASAX) together hold about a quarter of the firm's assets. The funds can range across markets, and invest in stocks, bonds, cash, precious metals, currencies, and derivatives (the flash crash involved a sale of futures).

Long-term, the fund routinely has beaten the S&P 500. But it stumbled earlier this year due to the poor performance of non-U.S. equities. In the second quarter Asset Strategy lost 7%, placing it in the bottom decile of its peer group. Year to date, however, the fund is up about 10%.

W&R MISSED SECOND-QUARTER earnings estimates, partly because a pension-fund client, seeking to invest in nonequity asset classes, made a large withdrawal. As a result, assets under management fell 5% from the first quarter. Analysts expect earnings to clock in at $204 million, or $2.38 a share in 2013, up from an estimated $183 million, or $2.13 a share, this year, and last year's $177 million, or $2.06 a share.

The Bottom Line

W&R's mutual funds have strong track records, but the company's stock has underperformed in recent years. One investor sees potential returns of 10% or more.

Waddell & Reed trades for 14.6 times earnings, below peers. The company has net cash of nearly $4 a share, effectively reducing its multiple, and providing plenty of funding for stock buybacks and regular dividend increases. Dalton notes that W&R's enterprise value hasn't changed much in the past decade, but sales and cash flow have nearly tripled.

With so much to do, Herrmann, 69, shows no signs of retiring. Instead, he prefers to tick off a list of catalysts for the stock: "We have continued positive flows in a difficult market where other people are struggling. We've come from being a relatively small player consistently losing share to one with almost $100 billion in assets and gaining share for a decade."

And eventually, equities will return to favor. "I may be a fossil, but I think this business is still about greed and fear," Herrmann says. If so, W&R shares could be ready for takeoff.